A Dumb Reason to Buy Twitter

By Markets Fool.com

Image source: Twitter.

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According to multiple rumors and press reports, Twitter (NYSE: TWTR) could be on track to being acquired soon. This is fueling plenty of speculation around the stock. Shares of Twitter were trading as low as $14 per share in June, and they are above $23 as of this writing.

When something like this happens, investors could feel tempted to buy Twitter stock in anticipation of an official purchase announcement. If things work out as expected, and this is a really big "if", then it would be possible to make a quick profit on the stock. Nevertheless, these kinds of maneuvers are usually riskier and more uncertain than they look at first sight.

The rationale for an acquisition

Twitter has many strong advantages. The network has reached a considerable scale, with over 313 million monthly users around the world. All kinds of celebrities and renowned public figures have a presence on Twitter, which speaks well for its relevance and staying power. Since Twitter is all about real-time messages, the platform is especially valuable when it comes to disseminating information and covering live events.

However, growth has materially slowed down lately -- the company increased its user base by a modest 3% year-over-year during the second quarter. Twitter is implementing different initiatives to make the user experience simpler and easier to enjoy, while at the same time expanding into promising areas such as live video. However, investors are broadly disappointed with the company's performance, and an acquisition could provide a more direct path for Twitter to better capitalize on its potential.

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Based on recent reports, companies like Disney, Salesforce.com, Microsoft, and Alphabet (NASDAQ: GOOG) (NASDAQ: GOOGL) are among the parties interested in a potential acquisition. While some of these names make little sense, a Twitter purchase by an online advertising powerhouse such as Alphabet sounds like a reasonable idea.

Alphabet is one of the strongest companies in the online world thanks to the impressive ubiquity of Google. The company knows how to make money in online advertising, and it has seven different platforms with over 1 billion users each: Google Search, Android, Maps, Chrome, YouTube, Google Play, and Gmail. In spite of its efforts, Google has never gained much traction in social media, so Google and Twitter could be a good match from a strategic perspective.

Alphabet has nearly $78.46 billion in cash and equivalents plus marketable securities on its balance sheet, while Twitter has a market capitalization value around $16.6 billion. This means that Alphabet could easily swallow Twitter, and even pay a considerable premium versus current market value if it wanted to do so.

Don't buy Twitter for the wrong reasons

Don't get me wrong, Twitter is an enormously valuable platform, and the stock offers considerable upside potential if management can jump-start user growth. When it comes to the prospects for an acquisition, it's not too hard to understand why a bigger industry player like Alphabet could be interested in buying such a unique platform.

However, investors should refrain from making buy or sell decisions based on the chances of an acquisition in the short term. That would be speculation as opposed to investing, and even the most seasoned professionals can make expensive mistakes when trying to read the crystal ball in these kinds of situations.

Hedge funds and other sophisticated investors have fully dedicated teams of specialists that try to figure out the chances for these kinds of transactions, and then they bet accordingly, be it on the long or short side. It's highly unlikely that an individual investor will outsmart the professionals when it comes to speculating on mergers and acquisitions, so this is not a game that most investors should be playing. Smart investing is about picking the right battles to fight, and trying to play the rumors of a Twitter acquisition is an uphill battle.

It's practically impossible to tell for certain if Twitter will be acquired or not. Even if a purchase does effectively go through, the current stock price is already incorporating such a possibility to a considerable degree, so it's hard to say what the upside potential would be in such a scenario. In fact, it's entirely possible that Twitter could be purchased for a price below current market prices in the middle term, so investors could still lose money even if Twitter gets acquired.

For investors who believe in Twitter's value as a social media platform and as a business, there are plenty of good reasons to consider a long position in the stock. However, short-term acquisition rumors are definitely not one of those good reasons.

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Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Andrs Cardenal owns shares of Alphabet (A shares), Alphabet (C shares), and Walt Disney. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Twitter, and Walt Disney. The Motley Fool owns shares of Microsoft. The Motley Fool recommends Salesforce.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.